Social Impact Bonds are Booming

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Social impact bonds are fairly new funding vehicles for social impact, with the first agreement dating back to 2010; however, the model was first advocated 22 years prior to that by a New Zealand economist in 1988. As with all things funded by the U.S. government, these bonds have a super appealing nickname: Pay for Success Initiatives.

What is a Social Impact Bond?

A social impact bond  brings together private investors and public dollars to solve tough social issues. It's essentially an agreed upon bounty. Ideally, the business-minded investors fund innovative projects that make a substantial dent in an entrenched problem that is costing the government X dollars. In exchange for funding the successful project and reducing their costs, the government entity pays an agreed upon amount, theoretically sharing the cost savings they realized.

In the past few weeks, three new social impact bonds were announced nationwide:

Goldman Sachs, billionaire John Arnold, and other partners just funded the largest social impact bond ever. As of yesterday, these philanthropic investors set the record with a $27M social impact bond aiming to prevent young men in Massachusetts from returning to incarceration. In 7 years, if the project realizes the projected 40% reduction in in incarceration among program participants, then the investment is paid back with 5% annual interest by the Massachusetts' Juvenile Justice Department.

The funding from the investors is split between a large nonprofit, Roca, and a nonprofit advisory firm, Third Sector Capital Partners. Roca will be doing the heavy lifting, working with just under 1,000 young men, ages 17-23, to achieve the desired outcomes.

This begs the question: What makes this any different from direct government funding of nonprofits, which has been going on for decades?

There's a lot of money on the line; therefore there's greater accountability to the outcomes which will theoretically spur increased collaboration and innovation, leading to better outcomes than have been achieved through the government-nonprofit funding model.  In this example, if the initiative fails, both the investors and the nonprofit will suffer, as the nonprofit has agreed to defer $3.3M in fees.

Additionally, the government doesn't have to pay unless the results are achieved, which is a lot more palatable to tax payers who are funding these social programs. In the Goldman deal, Massachusetts stands to save between $1M and $45M; the corresponding "success payments" range from $0 to $27M.

New York State broke new ground just weeks ahead of the Goldman-Massachusetts deal with the first state-led social impact bond with a $13.5M deal, which was also the first-ever to be distributed through a leading wealth management platform, Bank of America Merrill Lynch, to qualified private and institutional investors.

Similar to the Massachusetts bond, the deal targets the ultra-expensive criminal justice system, aiming to expand comprehensive reentry employment services to 2,000 former inmates in NYC and Rochester in an attempt to reduce recidivism and re-incarceration.

On the other side of the country, California also announced a social impact bond this week. The much smaller $2.5M bond is more generalized, aiming to improve social services throughout the state over the next two years by engaging nonprofit and government leaders in an active learning group. The initiative illustrates some hesitancy - hoping to incubate the social impact bond concept through the learning group toward expediting successful future agreements.

Are Social Impact Bonds Smart? 

Critics suggest that because the public funds must be budgeted, regardless of whether the project works, social impact bonds don't actually increase capital for social program, instead displacing it from other programs. Additionally, it's expensive to set up the complex financial and legal mechanisms required to structure such agreements.

It's still too early to tell if any initiatives funded by social impact bonds have or will produce promising (and profitable) results, but many would probably agree that any innovative idea for better social outcomes from public funding is worth a shot when we only pay for real results.